Identifying Overvalued Markets

[Jack]

Methodology:

A)Average house price, 1997; average house price, 2007
--Averarage annually compounded appreciation rate found using discounting techniques

B)Percentage change in CPI, 1997 - 2007, averaged out by dividing the sum total by the time period.

-Average annual inflation-adjusted appreciation rate found by subtracting A - B.

Some interesting findings! These should suggest which markets are most susceptible to a significant pullback in prices, as those which went up the fastest and the most should usually also come down the fastest and the most in the recession that we`re in. The higher the number, I would suggest, the more risk (today`s market activity also tends to support these findings):

01) Edmonton, AB 8.7%
02) Calgary, AB 7.9%
03) Saskatoon, SK 6.5%
04) Victoria, BC 6.2%
05) Montreal, QC 5.6%
06) Vancouver, BC 5.3%
07) Winnipeg, MB 5.0%
08) Quebec City, QC 4.9%
09) Regina, SK 4.8%
10) Halifax, NS 4.6%
11) Ottawa, ON 4.3%
12) Toronto, ON 3.7%
13) St. John`s, NL 2.8%
14) Saint John, NB 2.7%

In my opinion, in terms of real gains (inflation-adjusted), anytime you`re going above roughly 5%, you`re getting into dangerous territory. Edmonton & Calgary`s numbers look scary, and definitely indicative of a bubble. This lends more proof to my "herd mentality" theory from last week.

 

[Dan_Eisenhauer]

QUOTE (Jack @ Dec 13 2008, 09:07 AM) Methodology:

-Average house price, 1997; average house price, 2007
--Averarage annually compounded appreciation rate found using discounting techniques

-Percentage change

St. John`s, NL: 4.9% - 2.1% = 2.8%

Saint John, NB: 5.0 - 2.3 = 2.7

Quebec City, QC: 7.0 - 2.1 = 4.9

Toronto, ON: 6.0 - 2.3 = 3.7

Regina, SK: 7.2 - 2.4 = 4.8

Calgary, AB: 11.2 - 3.3 = 7.9

Victoria, BC: 7.9 - 1.7 = 6.2

Halifax, NS: 7.0 - 2.4 = 4.6

Montreal, QC: 7.7 - 2.1 = 5.6

Ottawa, ON: 6.6 - 2.3 = 4.3

Winnipeg, MB: 7.3 - 2.3 = 5.0

Saskatoon, SK: 9.0 - 2.5 = 6.5

Edmonton, AB: 11.7 - 3.0 = 8.7

Vancouver, BC: 7.1 - 1.8 = 5.3

And how do those figures help us identify overvalued markets? What is your point?

Market value is what a willing seller and a willing buyer agree to pay at a given time. If incomes are going up in one area, with no price change, then the affordability improves. However, that scenario will almost never happen. Incomes and housing prices will increase almost hand in hand.

Incomes in Alberta went up substantially over the last few years. Housing prices followed. That does not make housing prices overvalued. In fact, affordability stayed within acceptable levels, and is still within those levels.

Housing costs in Vancouver have, for as long as I have known the market, lead prices across Canada. That just makes housing in Vancouver more expensive than anywhere else in Canada. It does not make it overvalued.

I am just arguing against the above table. Housing values across the country are dropping slightly. That is a sign of overvalue, not the average price increases over a ten year span. And I am not even sure that falling housing prices can be truly connected to overvalue, but to a general lack of confidence in the economy

.

 

[Jack]

QUOTE And how do those figures help us identify overvalued markets? What is your point?It helps identify which markets have experienced the biggest run-un in this last bull market. Now that things are going the other way, it might indicate which markets are most susceptible to increased downward pressure on values. Look at the top-two cities, Edmonton and Calgary - have these not experienced the two sharpest declines in Canada? The answer is yes, they have.
QUOTE Incomes in Alberta went up substantially over the last few years. Housing prices followed. That does not make housing prices overvalued. In fact, affordability stayed within acceptable levels, and is still within those levels.

Did incomes really go up substantially? Are you sure about that?

The answer is that you`re right, they did experience the biggest gross increase in Canada, but you might be surprised at how they rank vis-a-vis the other provinces in terms of inflation-adjusted average weekly earnings growth from 2006 - September `08:

01) New Brunswick: 3.5%
02) Saskatchewan: 3.1%
03) Alberta: 2.6%
04) Newfoundland: 2.1%
05) Manitoba: 1.8%
06) British Columbia: 0.7%
07) Ontario: 0.3%
08) Quebec: 0.1%
09) Prince Edward Island: (0.6)%
10) Nova Scotia: (1.9)%

QUOTE Housing costs in Vancouver have, for as long as I have known the market, lead prices across Canada. That just makes housing in Vancouver more expensive than anywhere else in Canada. It does not make it overvalued.

Again, are you sure? Check out RBC`s affordability index. Their percentage-of-income figures are crazy. It does make it overvalued, because the fundamentals (incomes) don`t seem to support the price levels.

Here`s a direct excerpt from Don Campbell`s awesome book, Real Estate Investing in Canada:

"...a well-balanced market for investors is a market that has a Housing Affordability Index of about 33 percent...Cities and towns that are above this rate are often overpriced for investors...if the city`s index is 5 percent or more above this mark, it is an indicator that the market is turning speculative and that the fundamentals are getting out of balance..."

So, disagree with me if you choose, but you`re thus also disagreeing with Mr. Campbell

 

[ZanderRobertson]

I agree, Edmonton and Calgary are overvalued, they`re now correcting. Great! Buying opportunity for those willing to take action. Texas is better, but I don`t live there. There are some phenomenal deals in China right now, explosive growth, cheap land, and VERY affordable. Unfortunately I don`t speak Chinese or have the connections to capitalize in this market. Manitoba and New Brunswick, yeehaw, good for those investing there, I`m sure with the right kind of cash flow, investors in these markets will do well. I don`t live there either, perhaps it`s worthwhile to the investor who either A) lives these areas, or B)has a strong enough team and system to execute there. I`m not either A or B yet, so no good for me now. Some other REIN members fit these descriptions. I know from reading Thomas`s posts and website that his company`s been buying in SASK, AB, TEXAS, ONTARIO, AND BC lately. He seems to be doing alright with his Business of Real Estate Investing. Opportunities are everywhere. but only for those with the systems, relationships, and follow through.good job analyzing the numbers. anyone on this forum care to share their experiences of phenomenal results in every and any market in canada? I have no doubt they exist and will in the future!good luck to everyone in the Business of Real Estate Investing.

QUOTE (Jack @ Dec 13 2008, 12:07 PM) It helps identify which markets have experienced the biggest run-un in this last bull market. Now that things are going the other way, it might indicate which markets are most susceptible to increased downward pressure on values. Look at the top-two cities, Edmonton and Calgary - have these not experienced the two sharpest declines in Canada? The answer is yes, they have.



Did incomes really go up substantially? Are you sure about that?

The answer is that you`re right, they did experience the biggest gross increase in Canada, but you might be surprised at how they rank vis-a-vis the other provinces in terms of inflation-adjusted average weekly earnings growth from 2006 - September `08:

01) New Brunswick: 3.5%
02) Saskatchewan: 3.1%
03) Alberta: 2.6%
04) Newfoundland: 2.1%
05) Manitoba: 1.8%
06) British Columbia: 0.7%
07) Ontario: 0.3%
08) Quebec: 0.1%
09) Prince Edward Island: (0.6)%
10) Nova Scotia: (1.9)%



Again, are you sure? Check out RBC`s affordability index. Their percentage-of-income figures are crazy. It does make it overvalued, because the fundamentals (incomes) don`t seem to support the price levels.

Here`s a direct excerpt from Don Campbell`s awesome book, Real Estate Investing in Canada:

"...a well-balanced market for investors is a market that has a Housing Affordability Index of about 33 percent...Cities and towns that are above this rate are often overpriced for investors...if the city`s index is 5 percent or more above this mark, it is an indicator that the market is turning speculative and that the fundamentals are getting out of balance..."

So, disagree with me if you choose, but you`re thus also disagreeing with Mr. Campbell

 

[JohnS]

QUOTE (Jack @ Dec 13 2008, 12:07 PM) Methodology:

A)Average house price, 1997; average house price, 2007
--Averarage annually compounded appreciation rate found using discounting techniques


Now, I`m not a stats guy, but isn`t there a pretty major flaw in your methadology? You`re basically taking 2 snapshots and comparing them to see if the 2nd is overvalued. But, what if the first was really undervalued or overvalued? That`s what you`re basing your whole comparison on, and if it`s wrong.....

Overall, I much prefer RBC`s Housing Affordability Index, although I wonder what it would look like if they started using 35-year amortizations, seeing as how I seem to remember hearing from Don, about a year ago, that about 50% of all new mortgages used them.

Have a good one, all!

JohnS

 

[Jack]

QUOTE Now, I`m not a stats guy, but isn`t there a pretty major flaw in your methadology? You`re basically taking 2 snapshots and comparing them to see if the 2nd is overvalued. But, what if the first was really undervalued or overvalued? That`s what you`re basing your whole comparison on, and if it`s wrong.....

No, that`s not what I`m doing.

I`m taking value "A" (1997) and finding out what the average annual inflation-adjusted appreciation rate would`ve been which led to it being worth value "B" (2007). I`m finding the rate at which it appreciated over those ten years.

 

[GarthChapman]

Calgary`s annual appreciation rate from 1972 though 2008 is about 8% - that is a 36 year measure. This suggests that, in Calgary, 8% is sustainable over the long term. Edmonton`s numbers are about the same.

So it seems to me that our marketplace containing low taxes, a generally bouyant economy, growing population low unemployment, etc, etc is what makes these appreciation figures sustainable, where other areas of the country do not fare so well. These look to me like economic fundamentals at work.

Go to www.demographia.com for interesting insites into why certain markets are unaffordable, and will continue to be so over the long term (like Vancouver), and others, like Dallas Texas, will remain very affordable over the long term. You may be surprised to learn that municipal planning has a lot to do with this.

 

[Dan_Eisenhauer]

This evening is the first time I have looked at the Demographia website. It confirms on page 23, I think, on this link why Vancouver prices are so high. In a nut shell... landlocked with mountains to the north, an international border to the south, water on the west, and large tracts of Agricultural Land Reserve surrounding the city. and more mountains to the east. Add political interference, high demand, and you have a recipe for high prices.

I was not trying to equate Affordability and Market Value in my previous post in this thread. There is often a disconnect between the two. But, as we have seen, at some point there will have to be a correction when affordability becomes out of reach for the masses. Vancouver seems to be going through that now. However, IMHO, Vancouver`s affordability will never reach the levels of affordability found in Canada`s less expensive cities.

 

[Nir]

Sorry Jack, your basic assumption that past performance can help predict future performance is false. If it were that easy you would be surfing in Maui now and I would be planning my next vacation in... Bora Bora (thanks to making millions buying and selling stocks)

Let`s all agree to think hard and use common sense as much as we can before recommending sophisticated investors what to do with their money.

I do appreciate you sharing the raw data though. Cheers.

 

[joe123]

Over Value? Check the following stats, all residential averages:

Saskatoon November 2005 average was $152,747, Nov08 it is $278,495, that is a 82% increase
Regina November 2005 average was $123,712, Nov08 it is $222,179, that is a 80% increase
Edmonton November 2005 was $198,267, Nov08 it is $318,588, that is a 61% increase

Also:
Saskatoon Pre-boom about Nov-06, $167,430 to Peak Boom about Jun-08, $310,386 an increase of 85%
Regina Pre-boom about Nov-06, $131,812 to Peak Boom about Jul-08, $246,463 an increase of 87%
Edmonton Pre-boom about Jan-06, $199,148 to Peak Boom about May-07, $354,410 an increase of 78%

So by this Saskatchewan went up MORE and FASTER.

So if by Jacks reasoning the faster they go up, the harder they fall, should Saskatchewan be dropping more?
If by comparing to the differences of 2005, Saskatchewan is OVER priced by 12%

 

[GarthChapman]

QUOTE (joe123 @ Dec 14 2008, 12:33 AM) Over Value? Check the following stats, all residential averages:

Saskatoon November 2005 average was $152,747, Nov08 it is $278,495, that is a 82% increase
Regina November 2005 average was $123,712, Nov08 it is $222,179, that is a 80% increase
Edmonton November 2005 was $198,267, Nov08 it is $318,588, that is a 61% increase

Also:
Saskatoon Pre-boom about Nov-06, $167,430 to Peak Boom about Jun-08, $310,386 an increase of 85%
Regina Pre-boom about Nov-06, $131,812 to Peak Boom about Jul-08, $246,463 an increase of 87%
Edmonton Pre-boom about Jan-06, $199,148 to Peak Boom about May-07, $354,410 an increase of 78%

So by this Saskatchewan went up MORE and FASTER.

So if by Jacks reasoning the faster they go up, the harder they fall, should Saskatchewan be dropping more?
If by comparing to the differences of 2005, Saskatchewan is OVER priced by 12%

Will someone define over-valued for me?

I think we should be talking about levels of affordability.

Again refer to the affordability study on www.demographia.com for some clarity on this issue. In the long run there is more than just economic fundamentals and supply & demand driving property values.

 

[nepoez]

Some say there is global warming, some say that`s nonsense and that the earth goes through cycles from ice ages to the climate we currently live in, and eventually back to ice age and so on.

I curious about whether we should assume that the average appreciation will continue to be 8% just because the past 36 years performed that way. What about the past 150 years? Perhaps the past 30 years we`ve been living under a certain type of political/economic climate, which gave that average, different from the 30 years before that, maybe different from the next 30 years from now? Perhaps the past 30 year was a long term boom?



QUOTE (GarthChapman @ Dec 13 2008, 09:19 PM) Calgary`s annual appreciation rate from 1972 though 2008 is about 8% - that is a 36 year measure. This suggests that, in Calgary, 8% is sustainable over the long term. Edmonton`s numbers are about the same.

So it seems to me that our marketplace containing low taxes, a generally bouyant economy, growing population low unemployment, etc, etc is what makes these appreciation figures sustainable, where other areas of the country do not fare so well. These look to me like economic fundamentals at work.

Go to www.demographia.com for interesting insites into why certain markets are unaffordable, and will continue to be so over the long term (like Vancouver), and others, like Dallas Texas, will remain very affordable over the long term. You may be surprised to learn that municipal planning has a lot to do with this.

 

[Thomas Beyer]

QUOTE (nepoez @ Dec 14 2008, 02:26 PM) Some say there is global warming, some say that`s nonsense and that the earth goes through cycles from ice ages to the climate we currently live in, and eventually back to ice age and so on.
There is global warming .. the only question is to what degree is man responsible for it ? 0.1% ? 4% ? 25% ? 50% ? 100% ? I`d say man is to blame somewhat, but less than 10% perhaps .. as Greenland was once icefree (hence the name !!) and there were far fewer humans around !

QUOTE (nepoez @ Dec 14 2008, 02:26 PM) I curious about whether we should assume that the average appreciation will continue to be 8% just because the past 36 years performed that way. What about the past 150 years? Perhaps the past 30 years we`ve been living under a certain type of political/economic climate, which gave that average, different from the 30 years before that, maybe different from the next 30 years from now? Perhaps the past 30 year was a long term boom?
US money supply went up 17% year-over-year .. if that is not inflationary I do not know what is .. (I`ll look up a website somewhere .. I saw it on CNN yesterday ..) .. as long as we have democracies with deficits we WILL have inflation and increased money supply ..

6% is a decent annual inflation to use for Canada .. possibly more in the future due to increased government bailouts, economic stimuli and higher deficits going forward.. and of course, some years it`ll be lower than that and some years higher ..

 

[seeu22]

QUOTE (nepoez @ Dec 14 2008, 03:26 PM) I curious about whether we should assume that the average appreciation will continue to be 8% just because the past 36 years performed that way. What about the past 150 years? Perhaps the past 30 years we`ve been living under a certain type of political/economic climate, which gave that average, different from the 30 years before that, maybe different from the next 30 years from now? Perhaps the past 30 year was a long term boom?

I have the same question myself. What about the last 150 years.

In the last 30 years we have seen a transistion from single income families to a society with primarly dual income families. We have seen people become comfortable with taking on large debt loads. The development of new mortgage products and longer ammortization periods is something that has only developed in the last thirty or so years.

These trends must account for some of that 8%. Since these trends have had there effect on housing affordability they won`t increase affordability going forward. The big question is how much contribution did these trends have.

Neil

 

[Jack]

QUOTE 6% is a decent annual inflation to use for Canada ..

6%? What do you base that on? I use the YOY percentage change in CPI.

If it`s 6%, Canadians have been experiencing real wage losses for quite some time. A more accurate annual inflation to use, unless my percentage change in CPI method is wrong, is about 2.0 - 2.5%. For Alberta, the ten-year average is 3.3%.

 

[TommyK]

QUOTE (Dan_Eisenhauer @ Dec 13 2008, 11:15 PM) This evening is the first time I have looked at the Demographia website. It confirms on page 23, I think, on this link why Vancouver prices are so high. In a nut shell... landlocked with mountains to the north, an international border to the south, water on the west, and large tracts of Agricultural Land Reserve surrounding the city. and more mountains to the east. Add political interference, high demand, and you have a recipe for high prices.
I was not trying to equate Affordability and Market Value in my previous post in this thread. There is often a disconnect between the two. But, as we have seen, at some point there will have to be a correction when affordability becomes out of reach for the masses. Vancouver seems to be going through that now. However, IMHO, Vancouver`s affordability will never reach the levels of affordability found in Canada`s less expensive cities.

I agree. As much as Vancouver is WAY over-priced by affordability standard, it is the ONLY major metropolitan city that has all the desirable qualities that attract immigrants, other Canadians, and most importantly, retirement folks from all over the world. The climate is mild (though lots of rain, but it`s not freezing cold), the city is beautifully surrounded by mountains and water. What more can you ask for? It`s almost like San Fransisco in my opinion!

I am a firm believer that affordability is only one of the ways to project future value. It`s not an absolute figure to determine market price of real estate. There are tangible qualities (such as climate, weather, geographic advantages like water and mountains) and intangible qualities (such as demographic mix, cultural diversity, political influence and employment) that make up the DESIRABILITY to live.

However, I do believe the principle of what goes up must come down; and what goes up higher and faster will come down harder and deeper! (hence Edmonton and Calgary are experiencing 18 months of price dropping since last summer). Hopefully once the US economy is stabilized, and oil price rebounds, we`ll see a steady growth and recovery in the market. Cross your fingers!

Regards,
Tommy

 

[Thomas Beyer]

QUOTE (Jack @ Dec 14 2008, 06:58 PM) 6%? What do you base that on? I use the YOY percentage change in CPI.

If it`s 6%, Canadians have been experiencing real wage losses for quite some time. A more accurate annual inflation to use, unless my percentage change in CPI method is wrong, is about 2.0 - 2.5%. For Alberta, the ten-year average is 3.3%.
see my post on the "REIN member only" section with a 50 year chart showing average appreciation in calgary of 5.97% - a 50 year trend ..

I`ll do a new post in a few days with REAL inflation data not the government fudged CPI .. and it also show, low and behold: 6% for 40+ years (it is US data)